December 2009

Legal Update

In this period of economic uncertainty, it is important that directors and advisors of companies are aware of their position as creditors of companies which might be facing the threat of insolvency. In this update, we look at three recent cases that consider the position of unsecured creditors.

BLV Realty Organisation Limited and Another v Batten and Others [2009] EWHC 2994 (CH) centred on the administration of Zegna II Holdings which had acquired a number of properties at 3-10 Grosvenor Crescent to re-develop. It engaged BLV to manage and co-ordinate the project. The project went over budget and behind schedule so that the redevelopment costs exceeded the available funding. The Bank made demand for repayment and eventually applied to Court for an administration order, which was duly made on 10 July 2009.

Upon appointment, the Administrators sought to establish the cause of the delay and overspend, and considered whether it was appropriate and in the interests of the creditors to terminate the agreement with BLV. Notice to terminate was subsequently given on 14 July 2009. Three months later, BLV applied to Court seeking an order that its outstanding pre-administration invoices be paid by the Administrators, that the termination notice be withdrawn and BLV retained as development manager, alternatively that the Administrators be removed or, as a further alternative, that the Administrators be directed to retain new solicitors to review BLV’s position. BLV claimed that the termination of their agreement was wrongful and amounted to a breach of duty by the Administrators to perform their functions in the interests of the creditors as a whole, and caused unfair harm to BLV.

Mr Justice Norris rejected the application, finding that BLV had not established that the termination was wrongful and constituted a breach of duty. He referred to administration as a class remedy, though that did not require the Administrators’ obligations to be performed in an identical way in relation to each and every constituent of the class. The interests of the creditors as a whole would prevail over the interests of individual creditors, which might result in different treatment. The Judge was clear that it was a matter of commercial judgment for the Administrators and was equally clear when he said that unequal or differential treatment is not necessarily unfair treatment. The termination of a weakly performing contractor would be treated differently because there are sound commercial reasons for choosing some, rather than all, existing contracts to carry the project to completion. The Judge did add that different treatment will require an explanation. Finally the Judge noted that it was not BLV’s interests as a creditor that were being harmed; its complaint was that as a contractor its services were no longer required whereas those of other contractors had been retained. The Judge said that an application made as a creditor must be made in the capacity as a creditor. This case highlights the caution creditors must use when considering their position if a contract has been terminated. Just because a creditor suffers loss does not mean unfair harm has been caused.

One way in which a creditor may defeat the principle that all unsecured creditors are ranked equally is to establish a proprietary claim over funds held by a company. Many customers believe that if they have paid a deposit for goods to be delivered at a future date and the supplier then goes into an insolvency procedure before those goods are delivered and is unable to fulfil that order, that the deposit will be returned. Unless specific arrangements have been made, this is not generally the case. Often directors of companies who face financial difficulties will attempt to ring fence monies received by way of a trust arrangement to protect them from the general body of creditors.

Re: BA Peters [2008] EWCA Civ 1604 involved a company that, amongst other things, sold and purchased boats, both for itself and as a broker for clients. It had two bank accounts; a client account and a current account. The current account was overdrawn at all material times, whilst there was a surplus in the client account consisting of deposits that customers had paid for the purchase of boats that had not been delivered. Three key issues arose: whether or not customers had a proprietary claim in relation to payments into the client account; whether clients who paid into the overdrawn current account could nevertheless maintain a proprietary claim; and whether clients, having paid into the overdrawn client account, would have a proprietary claim in the surplus in the client account.

The Judge held that, despite the fact that monies had been mixed in the client account, each customer whose deposit had been paid into the client account was entitled to the value of the payment made into the client account. However, monies paid into the overdrawn account were used to reduce the liability to the Bank and therefore effectively disappeared. The clients who had paid into the overdrawn account also failed to establish a proprietary claim in the surplus because they could not identify any trust fund over which a proprietary claim could operate; as soon as the money was paid into the current account, its identity was extinguished in favour of the Bank.

This case centred on client deposits but different factors might affect the position in relation to suppliers. In order to create an effective trust by which to protect deposits, the object i.e. those for whose benefit the trust is set up, must be clearly identified. Previous case law (OT Computers Limited v First National Tricity Finance Limited [2003] EWHC 1010(Ch)) has established that reference to “urgent suppliers” was not sufficient and therefore that particular trust failed, leaving suppliers with no proprietary claim. Suppliers should therefore consider their position carefully when they become aware that a customer may be suffering financial difficulties, and take advice as to the best way to protect their position.

Finally, in general, most trade creditors are unsecured creditors and therefore have little control in any insolvency process. They rely, therefore, on the liquidator or administrator to comply with their statutory duty to act in the best interests of the creditor as a whole. However, the case of Charalambous and others v B&C Associates and Another [2009] EWHC 2601 (Ch) is a timely reminder that in the absence of some special relationship between the creditor and the administrator, an administrator owes no general common law duty of care to creditors by which a claim in negligence would be established against that administrator. In this case, Mr Charalambous had been the managing director of the company which went into administration. The company had been loaned money by a holding company that was owned by the trustee of an off shore-trust, the beneficiaries of which were Mr Charalambous’ children. In this case, the loan was secured by a debenture. After the administration Mrs Charalambous petitioned for a divorce. In the ancillary relief proceedings Mrs Charalambous received no financial provision, as Mr Charalambous had no assets; however, the family Court indicated that the children would obtain the benefit of the disposal of the company’s assets via repayment of the secured loan to the holding company. Unfortunately, nothing was realised in the administration and the children sought damages from the Administrator for negligence and misappropriation of the company’s assets. The Court held that there was nothing to suggest that a special relationship had existed between the children and the administrators. The fact that an administrator or liquidator knew of a Company’s sole secured creditor and appreciated that that creditor was in serious need of whatever money could be realised, did not in itself create a special relationship.

It is therefore clear that if an unsecured creditor is concerned about the way in which an administration or liquidation is conducted, any redress would be through the Insolvency Act 1986.

Kathryn Tait, Boyes Turner Solicitor.

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